Housing Agency's Reserves at Risk

By

Nick Timiraos

Updated Feb. 13, 2012 2:48 p.m. ET

The Federal Housing Administration will exhaust its reserves over the coming year, according to budget projections released Monday, which would require a Treasury infusion for the first time in its 78-year history.

But Obama administration officials said more recent developments, including fines that will go to the FHA from last week's $25 billion mortgage settlement with five major banks, could cover any shortfall and obviate the need for taxpayer funding.

The FHA has burned through its reserves over the past three years as defaults mount on loans it guaranteed as housing markets deteriorated. FHA-backed mortgages are an attractive option for borrowers because they can make down payments as low as 3.5%. But as home prices continue to fall, many of those borrowers have fallen underwater, where they owe more than their homes are worth and are at greater risk of default if they experience income shocks.

The estimates by the White House's Office of Management and Budget show that the FHA's capital reserves, which stood at $4.7 billion in October, would be wiped out in the coming year, forcing the agency to seek nearly $700 million from the U.S. Treasury.

FHA officials said they could collect as much as $1 billion from last week's settlement between federal agencies, 49 state attorneys general, and five banks as a result of false claims submitted to the agency.

"It's highly unlikely that we'll need any special assistance from the Treasury given the policy changes we're making as well as the settlement dollars," said Carol Galante, the FHA's acting commissioner.

The FHA also plans to announce an increase in mortgage insurance premiums that it charges to borrowers later this month, Ms. Galante said. Those increases come on top of a 0.1 percentage point increase in premiums required last year by Congress.

A spokeswoman for the White House budget office said that its projections for the FHA's reserves were "no longer accurate" as a result of last week's bank settlement.

Any taxpayer assistance would be a watershed moment for the New Deal-era agency because it has always been self-funded. The FHA now backs nearly $1 trillion in mortgages, and more than 9% of those loans are at least three months past due.

The FHA doesn't have to ask Congress for money if it runs out of cash. Instead, it has what is known as permanent and indefinite budget authority, giving it an effective credit line from the Treasury.

The FHA keeps two different reserve accounts—a primary account that must keep enough cash on hand to pay for all estimated losses on loans it has guaranteed, and a secondary account for reserves that exceed projected losses. Congress requires the FHA to have enough cash in the secondary account equal to 2% of all loan guarantees, a level that the agency breached in 2009.

The primary account had nearly $27 billion to cover all estimated losses at the end of September 2011, while the secondary account had nearly $4.7 billion for additional losses.

But the budget projections show that the FHA will exhaust that secondary account over the coming year as those funds are moved into the primary account. It will also need $688 million for the primary account, which covers projected losses on its current portfolio over 30 years.

The report estimates that the account would return to the black by October 2013, with around $8.3 billion in reserve, and that it would return to the mandatory 2% reserve level by 2015.

The agency—which played a small role in the housing market during the boom years because private sector lenders provided loans with far more generous terms—has become a major source of financing for home purchases since the mortgage meltdown.

The FHA doesn't make loans but instead insures lenders against losses for mortgages that meet its standards. It makes money by charging upfront and monthly insurance premiums to borrowers. The agency said Monday it would increase the annual insurance premiums by one quarter of one percentage point for loans that exceed $625,500.

The FHA's losses could expose yet another cost of the government's extraordinary efforts to prevent a deeper housing downturn, fueling a debate over how much support should be provided to the housing market. Many economists worry that a sharp pullback by the FHA could choke off credit and send home prices lower. Ms. Galante said the agency is focused on minimizing any losses without constricting housing markets that are "still stressed."

Loans guaranteed over the past two years are expected to turn a profit for the agency, but losses on loans insured between 2007 and 2009 are mounting. "It's no surprise that the fund is under some level of stress" as a result, said Ms. Galante.

The report comes just weeks after President Barack Obama proposed an initiative to allow millions of home owners to refinance their mortgages through the FHA if they can't currently qualify for low interest rates but are up to date on their loan payments.

The plan, which requires congressional action, would represent a dramatic expansion of the FHA by allowing the agency to refinance borrowers who owe more than their homes are worth. The White House says a levy on large financial institutions would create a separate reserve account used to protect taxpayers against losses from defaults.

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